| P | Q | Profit |
|---|---|---|
| 17 | 100 | 1000 |
| 16 | 150 | 1350 |
| 15 | 200 | 1600 |
| 14 | 250 | 1750 |
| 13 | 300 | 1800 |
| 12 | 350 | 1750 |
| 11 | 400 | 1600 |
| 10 | 450 | 1350 |
| 9 | 500 | 1000 |
| 8 | 550 | 550 |
| 7 | 600 | 0 |
Ilmu Ekonomi
Pertemuan 7
Prodi PIWAR Politeknik APP Jakarta
Recap on last week
We have learned the two extremens: perfect competition & Monopoly
In perfect competition, profit only last in the short run. As more firms join the market, price pushed down.
As long as there are profit, more firms will enter the market until zero profit is reached.
In the monopoly, profit maximization can last forever because no more firm can join in.
Today’s content
The imperfect competition: oligopoly and monopolistic competition.
A touch of externality ends the mid-term content.
Skutik Price Cartel
In 2017, AHM and YIMM, two of the biggest skutik makers, were charged by KPPU for an alleged price fixing.
In the perfect market, many producers are competing with each other, while in the monopoly, well, there’s no other producer.
If the market is shared by small number of producers, they can decide a price together to behave similar to a monopoly.
- this is called price fixing.
A hypothetical skutik market
Suppose skutik market behave like this table.
As you notice, increasing price is associated with decreasing demand.
Any monopolist operate in the skutik market have that revenue.
To simplify things, suppose per-unit cost is stagnant at 7 million IDR.
A monopolist will set P=13, produce Q=300 and gets 1800 as profit
A 2-firm competition
Unit Price
|
Monthly sales
|
Total Revenue
|
|---|---|---|
million IDR
|
1000 unit
|
million IDR
|
| P | Q | Profit |
| 17 | 100 | 1000 |
| 16 | 150 | 1350 |
| 15 | 200 | 1600 |
| 14 | 250 | 1750 |
| 13 | 300 | 1800 |
| 12 | 350 | 1750 |
| 11 | 400 | 1600 |
| 10 | 450 | 1350 |
| 9 | 500 | 1000 |
| 8 | 550 | 550 |
| 7 | 600 | 0 |
Suppose another firm enters the market and offering P=12.
Everyone will buy from the entrant.
the incumbent will have zero sales while the new entrant will get 1750 profit.
Since per unit cost is 7, the incumbent will offer a discount to match the price.
Eventually, P=7
A duopoly
Unit Price
|
Monthly sales
|
Total Revenue
|
|---|---|---|
million IDR
|
1000 unit
|
million IDR
|
| P | Q | Profit |
| 17 | 100 | 1000 |
| 16 | 150 | 1350 |
| 15 | 200 | 1600 |
| 14 | 250 | 1750 |
| 13 | 300 | 1800 |
| 12 | 350 | 1750 |
| 11 | 400 | 1600 |
| 10 | 450 | 1350 |
| 9 | 500 | 1000 |
| 8 | 550 | 550 |
| 7 | 600 | 0 |
A strategic firms know this. They will fare better if they collude and form a cartel.
Both can settle a price-fixing deal to limit their Q=150 and set the market price to P=13.
As you can see, this is a monopoly price and quantity.
Each will get profit=900, which is much higher than if they compete.
A Duopoly
A duopoly has a potential to produce a similar outcome as a monopoly.
As the example above, the duopoly market produces only 300 with price as high as 13, while a competition makes 600 where P=7.
In short, like a monopoly, duopoly also harm consumers and is inefficient.
However, a duopoly is harder to maintain because every oligopolist has an incentive to deviate.
Deviation
Unit Price
|
Monthly sales
|
Total Revenue
|
|---|---|---|
million IDR
|
1000 unit
|
million IDR
|
| P | Q | Profit |
| 17 | 100 | 1000 |
| 16 | 150 | 1350 |
| 15 | 200 | 1600 |
| 14 | 250 | 1750 |
| 13 | 300 | 1800 |
| 12 | 350 | 1750 |
| 11 | 400 | 1600 |
| 10 | 450 | 1350 |
| 9 | 500 | 1000 |
| 8 | 550 | 550 |
| 7 | 600 | 0 |
Suppose both producers agreed to produce Q=150 each at P=13
However, the incumbent decide that it will produce Q=200 instead.
Total Q=350 and P=12
Incumbent’s profit= 200×5=1000
Entrant’s profit= 150×5=750
Non-cooperative behavior
Any player in a duopoly have an incentive to behave non-cooperatively.
By being non-cooperative, the incumbent improve its profit from 900 to 1000 at the expense of the entrant’s profit.
If the entrant saw this coming, it will behave the same way. It is easy to see how a cartel can break down on its own.
This is the reason why an industry with an oligopolistic structure can have a less problematic market outcome than a monopoly in the real world.
Game played by oligopolists
Oligopolist realize their profits depend on other players and vice-versa.
This situation is called profit interdependence where your own profit depends on the action of others in the market.
- No interdependence in perfect competition.
- monopoly is a single player
essentially oligopolists play a “game” in which the success of a player depends on other players’ action.
This branch of economics is called game theory.
Game theory
Let us represent the previous case with a game theory framework.
There are 2 players: AHM and YIMM.
There are 2 actions each player can take: Produces 150.000 units of skutik or 200.000
There are 4 possible sets of payoff, or profit scenario.
This game can be represented with a 2 × 2 matrix. A table of game theory matrix is called payoff matrix.
Payoff matrix
YIMM
|
|||
|---|---|---|---|
| Q=150 | Q=200 | ||
| AHM | Q=150 | (900,900) | (750,1000) |
| AHM | Q=200 | (1000,750) | (875,875) |
each element of a payoff matrix consists of a profit from two players, hence two numbers.
Player 1 (AHM, left) vs player 2 (top, right)
payoff structure is (player 1,player 2) for every element.
Payoff matrix
YIMM
|
|||
|---|---|---|---|
| Q=150 | Q=200 | ||
| AHM | Q=150 | (900,900) | (750,1000) |
| AHM | Q=200 | (1000,750) | (875,875) |
For example, the top left payoff element means both players get 900.
Top right payoff element means AHM gets 750 while YIMM gets 1000.
etc
Payoff matrix
YIMM
|
|||
|---|---|---|---|
| Q=150 | Q=200 | ||
| AHM | Q=150 | (900,900) | (750,1000) |
| AHM | Q=200 | (1000,750) | (875,875) |
We get the situation on the top left when both players play (Q=150,Q=150).
We get the situation on the top right when players play (Q=150,Q=200)
In Which AHM set Q=150, YIMM set Q=200
Dominant strategy
YIMM
|
|||
|---|---|---|---|
| Q=150 | Q=200 | ||
| AHM | Q=150 | (900,900) | (750,1000) |
| AHM | Q=200 | (1000,750) | (875,875) |
You analize each player separately to see which strategy they will pick by comparing their payoff in different situation.
If you are AHM, which action you pick when YIMM pick Q=150? Which action you pick when YIMM pick Q=150?
Dominant strategy
YIMM
|
|||
|---|---|---|---|
| Q=150 | Q=200 | ||
| AHM | Q=150 | (900,900) | (750,1000) |
| AHM | Q=200 | (1000,750) | (875,875) |
If you are AHM, Q=200 is called dominant strategy because no matter what YIMM does, Q=200 give the best outcome.
Similarly, Q=200 is a dominant strategy for YIMM.
Nash Equilibrium
YIMM
|
|||
|---|---|---|---|
| Q=150 | Q=200 | ||
| AHM | Q=150 | (900,900) | (750,1000) |
| AHM | Q=200 | (1000,750) | (875,875)* |
Since both have Q=200 as a dominant strategy, then we called (Q=200,Q=200) as a Nash Equilibrium.
A set of actions is called Nash Equilibrium (NE) when nobody gains from deviating from that set.
Nash Equilibrium
YIMM
|
|||
|---|---|---|---|
| Q=150 | Q=200 | ||
| AHM | Q=150 | (900,900) | (750,1000) |
| AHM | Q=200 | (1000,750) | (875,875)* |
To analyze an NE, you can start from each possible outcome and see whether deviating gives a better payoff to anyone.
(Q=200,Q=200) is an NE because deviating gives a worse payoff for both
Prisoner’s Dilemma
This payoff structure is a typical of prisoner’s dilemma
A game is called prisoner’s dilemma when each player has an incentive to cheat regardless of what others do, but when both cheat, both are worse off.
That is why it is important for every players in this type a game to communicate with each other, but it is against the law in many countries.
Making a written contract is even worse.
Tacit collusion
It is possible to signal another player without having to meet each other.
AHM can try to set price high and see if YIMM would follow with a high price, signalling collusion.
If YIMM followed with a low price, it is easy for AHM to punish YIMM’s behavior by making a discount, hence both ended up at the NE.
Setting price is not against the law.
this behavior is called tacit collusion.
Dealing with oligopolies
It is even possible for a firm to mergers or making an acquisition to strengthen their market power.
That’s why governments often scrutinize mergers and acquisition. Sometimes even force big firms to separate their business.
Perhaps the best way to deal with oligopolies is to introduce competition.
- Lion group and GIA once considered an oligopolies until Air Asia come in.
- foreign comptition also improved telco market.
Dealing with oligopolies
Sometimes it is hard because an industry is a monopoly by nature due to economies of scale and/or network effect.
Wholesales, cinema, social media, telco, you name it.
small producers can be considered oligopolies if operate in a small market.
- Two minimarkets operate in a small town can be considered a duopoly.
- definition of market matters, again.
Monopolistic competition
Monopolistic competition
Monopolistic competition is also a type of an imperfect market, in which a seller may have a control over price.
It still have characteristics of a perfectly competitive industry, with only differnce is the goods is differentiated.
The differentiation is not so much that it still have a close substitute.
Example of a product differentiation
In a food court consists of 10 stalls, you might see different food types being offered.
- maybe 1 stall is Bakmi GM, another is KFC, Chinese food, italian food, Pecel, drinks, etc.
Each stall have a bit of control over their price because they have a specialized food.
However, charge too much and people will flee because other stalls are still food.
- if a portion of KFC is 100.000 IDR, I won’t mind eating bakmi GM everday.
Monopolistic competition
Suppose all 10 stalls offer Nasi Goreng with exact same quality, then it become a perfect competition where sellers will compete only on price.
Competing by making a different product can be called blue ocean strategy, while competing over cost can be called red ocean strategy.
blue ocean because you create your own market base, red ocean because you compete in an already crowded market and fight over a limited share of market.
Product differentiation
Monopolistic competition is driven by product differentiation:
differentiation by style/type like our food stall example. Other example: specializing in women’s clothing, or in utility vehicle.
differentiation by location: all indomaret sell the same goods, but we prefer one that’s near our location.
differentiation by quality: there’s $10 shoes, and there’s $100 shoes.
Product differentiation
Product differentiation can be annoying: streaming services, apple vs android vs windows
However, we generally don’t hate monopolistic competition because:
it improves variety in the market. (imagine if all cars are Avanza)
Cater everyone’s need (not all people buys cheap or expensive products)
Competition still push producers to innovate.
externalities
Externalities
Is another problem for perfect market because it creates interdependence, that is buyer’s or seller’s individual action affects the whole market.
The best example is pollution. A firm’s decision to lower its own cost by using high emission power plant imposes cost to everyone else.
Traffic is another good example: a car user contributes to a traffic jam and has no incentive to care about other road users.
Smoking causes bad health to smokers but also impose cost to everyone around the smoker. etc
Externalities
All of the examples on the previous slides are negative externalities.
An example for positive externalities:
- Having a bee farm and an apple tree farm leads to higher production because bees help pollinates apple tree.
- Having smart kids help not only a family but also the whole country.
Externalities also sometimes called spillover effects
Externalities
The problem with externalities is that the individual who do the action does not take into account the social cost and social benefit of their action.
That’s why government would like to limit the activities that cause social cost.
- this is typicall done via taxation.
On the other hand, activities that cause positive spillovers needs to be promoted / subsidized.
Examples?
- can you find an example for positive and negative externalities?
Externalities & Common goods
externalities can be mixed up with a common good.
A common is a type of good that can be consumed by everyone, but a consumption from a person leads to less good for others to consume.
This also creates interdependence: someone’s consumption affects consumption of others in the economy.
An example is a ground water, a meadow, or fish stocks.
Tragedy of the commons.
In a housing complex, people will make a ground water well for themselves.
However, ground water has limitation on how fast it recovers.
If more people in a housing complex make ground water well, there will be less water for others.
There is no incentive to preserve ground water individually, especially if you know your neighbours will also build ground water.
In the end, everyone consume unsustainably.
Tragedy of the commons.
This is called tragedy of the commons, a situation where everyone consume even more for their own benefit.
Another example is fish stock. If you know other fisherman will fish unsustainably, you might fish even more unsustainably to reap the benefit to yourself.
Like negative externalities, government usually tries to intervene to preserve common goods since it won’t solve individually.
Tax or quota are often use to deal with this situation.
Interdependence
In a perfect market, acting based on self-interest gives best outcome for the economy.
However, interdependence creates problem because acting based on self-interest may harm the economy overall.
Imperfect market: oligopoly.
Interdependence causes market failure: externalities & tragedy of the commons.
Unfotunately dealing with these problems are not easy. It is important for you to understand how problems arise from interdependence.
The end of part 1
What we’ve learned so far:
What is economics.
Perfect competition: how supply demand shape the market.
Market distortion: tax, price and quota policy.
The importance of elasticities.
Costs and how firms shape the market.
Market structure & interdependence
The end of part 1
This is the end the first part of our class.
Mid-term exam will only cover up to today’s content.
Starting next week is part 2 which is final exam materials.
Ilmu Ekonomi Pertemuan 7 Prodi PIWAR Politeknik APP Jakarta